April 8, 2022

By Harris L. Kempner, Jr., President

To take any position on the U.S. economy for 2022, one has to deal conceptually with the Russian invasion of Ukraine. There is no telling how far it will go, but IF it is restricted to Ukraine without weapons of mass destruction or other rocket attacks outside the Ukrainian border, I believe its effect on the U.S. economy will be negative but not crushing. Energy prices will trend somewhat higher than they might have in the short-term due to sanctions on Russian oil, but despite headlines, I believe there will be no full-scale blocking of the major exports of Russian oil that contributes to the overall world oil supply. Despite voluntary sanctions, in one way or another, the oil will flow. Think China and India as even larger customers for example. There may be Russian cyberattacks on Europe and us, and that could be destructive to our economies, at least in the short-term. Consumers and businesses in the United States and elsewhere will probably be more hesitant to make purchases. However, I still do not think at this point that Ukraine will be enough to change my present view of the huge and growing U.S. economy in 2022.

First, we need to understand the platform of Year 2021. Last year I thought the real GDP of the U.S. economy would be 5%-6% and inflation adjusted, 2% or 3% more. So, it would have been anywhere between a 7% – 9%, nominal GDP growth. Well, I got the very strong real GDP growth right, but I under-estimated inflation to a considerable extent percentage wise. Now the entire year was about a 6% real GDP, plus a GDP deflator of 4.30% for the whole year. A nominal GDP, therefore, for 2021 of over +10%. This was an extraordinary year. There was double digit nominal GDP growth. It’s particularly stunning because for the past 20 years we’ve been averaging only about 3% – 4% nominal growth. So what were the reasons for this exceptional strength in GDP in 2021 and how will they carry over, if at all, in 2022?

Basically, this was a recovery from the depth of 2020. It was characterized by multiple factors: An easy monetary policy by the Feds.

  1. A relatively high GDP deflator of +4.0% – 4.5% that helps the nominal GDP number.
  2. Strong fiscal stimulus by the Congress and the two Administrations, which also were very strong.
  3. Increased job openings of approximately 11.5 million.
  4. An unemployment rate that has already dropped to 4.2% in November and is projected to reach in the low 3% in 2022. This was caused by a creation of 6.4 million jobs in 2021, which is the greatest job creation year ever in the United States.
  5. Very strong consumer income and consumer spending due somewhat to government fiscal additions.
  6. Average hourly earnings hitting a 39-year high of 5.3%, however, this was severely undercut by high inflation, which is also affecting the prospects of 2022. Lower real earnings due to this, made many feel poorer.
  7. Very rapid profit increases by U.S. businesses, which allowed for extensive capital spending.

All these factors, and more, have led to an exceptional year for 2021 GDP. Some of them, especially monetary policy, will continue to give the economy strength in 2022.

However, there are now several factors which are militating against 2021’s extreme strength continuing in 2022.

  1. Ukraine – at the least some consumer hesitation, and some corporate indecisions as well, will reduce economic activity from what it might have been.
  2. The Omicron virus mutation, which is apparently less destructive but more transmissible than the Delta variant, has been a slight economic headwind, particularly in the first month of 2022. Between December 29th and January 10th, a huge 8.8 million workers reported not working due to being sick or caring for the sick. However, I think as evidenced by the eye-popping level of January retail sales – the best in 10 months at +3.8% – and excellent January employment figures, Omicron will only be a slight, temporary headwind.
  3. More importantly, for a slowdown the Fed is shifting its stance from ease to gradual tightening. This will eventually have a dampening effect on overall growth. The primary reason for this Fed change is their goal of reducing the demand-side of inflation, year-on-year. Inflation is at 30-year highs at this point of +7%. We believe the Fed will need to tighten significantly – higher rates – with some impact to economic growth; though note – there is always a delayed effect, and this will have more effect in 2023.
  4. Most of the previous $1.9 trillion fiscal stimulus programs by the Federal government referred to above will go away, including expanded child tax credits and payments, and the student loan forgiveness program. There are, however, $560 billion left to spend from the Recovery Bills of 2020/2021. The beginnings of the passed infrastructure bill spending will be a new, though gradual, fiscal positive – about $22 billion, so this is a mixed fiscal bag.
  5. The labor market is likely to be affected by even greater supplies of people turning out to work this year. We believe wage inflation will see its height in the first quarter of 2022, and then start downward as the supply increases. In fact, numbers announced for February indicated exactly that. There will still be inflationary pressures from labor but not as severe as they have been in the very recent past.
  6. Housing prices are up, and sales are coming down some.
  7. The supply side for goods will come into more balance during this year as supply chain issues are gradually resolved. This is particularly true in autos, which has been a major contributor to inflation because demand has remained solid, but supply has been hampered by chip shortages. This area is certainly going to reduce inflation later in the year and add to GDP on balance.

We think the combination of all these factors will reduce real GDP somewhat from 2021’s exceptional strength. However, there are still enough strengths that we forecast that the U.S. economy is going to remain quite strong in 2022, especially when compared to the 15 years preceding 2021. The momentum of the recovery is still in place. Our base projection is for U.S. GDP for the year 2022 to be 7.5% nominal, of which 3.0% will be real and 4.5% will be inflation.